Serious Money

March 5, 2014 11:18 am

Five years at 0.5 per cent

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Interest rates had to fall, but should they now rise?

Five years ago today, the Bank of England cut its base rate to 0.5 per cent and embarked on the first phase of quantitative easing. This week also marks five years since the stock market (as measured by the FTSE 100 at least) touched a low of 3,512.

It seems appropriate to reflect on these anniversaries even if I’m not quite sure what to think of them. I’ve never bought into the idea that negative real interest rates were all part of a great conspiracy to defraud the virtuous and reward the feckless. As we all dance for joy at news that another Chelsea mansion has sold for gazillions of pounds, it’s worth remembering that in late 2008 world trade ground to a halt and the financial system came close to total collapse. What else were governments and central banks supposed to do?

I do accept that there have been winners and losers from low interest rates. The winners have been governments (able to finance big deficits cheaply) and companies (able to shore up balance sheets using low-cost debt). Among the big losers have been older people.

Each year, about 400,000 people in the UK exchange their savings for an annuity, an insurance contract that pays an income for as long as you live. The income is linked to the yields on government bonds, which sunk to all-time lows following the cuts in interest rates. Annuity rates have dropped 20 per cent since 2009, so about 2m Britons have annuitised their savings – an irreversible decision – at historically miserable rates because they happened to reach retirement age during a financial crisis.

Low interest on savings accounts has also hit older people hard. In March 2008, the average cash Isa rate was 5.15 per cent, according to Moneyfacts. Now it’s 1.65 per cent. Factor in consumer price inflation and the real rates are 2.65 per cent then and -0.28 per cent now.

Mortgage borrowers have benefited greatly. Bank of England figures show that in early 2009, the average five-year fixed-rate mortgage cost over 5 per cent. Today, the average is 3.34 per cent, helped by schemes such as Help to Buy and Funding for Lending.

But as many older people own their own homes outright and cannot remortgage (other than through expensive equity release schemes) they have been less able to capitalise on cheaper home loans. True, their homes may be worth more than might otherwise have been the case, but you can’t spend housing equity in Sainsbury’s.

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Does all this mean that interest rates should have been raised much sooner? Not in my view. With the public finances in such poor shape, the government needed to shore up the tax base by keeping companies in business and working-age people in jobs. The improvement in economic data has been relatively recent; this time last year, we were still talking about triple-dip recessions. Cheaper home loans materially reduced many households’ outgoings at a time when real wage growth was virtually non-existent. And it’s worth noting too that while working-age benefits were cut, benefits for older people were left untouched or even enhanced.

Critics contend that ultra-low interest rates had undesirable side-effects, such as inflating asset prices. This is certainly true, but ordinary people benefited from this too. According to the Investment Management Association, retail investors poured £3.5bn into Isa funds in 2009 and over £4bn in 2010, as the stock market recovered.

Then there’s the global perspective. The Bank of England wasn’t the only central bank to cut interest rates. They’ve been at zero in Japan for years, and US and eurozone base rates are currently lower than UK ones. Yields on quality sovereign bonds likewise fell across the world. House prices and stock markets have recovered strongly in many other places. Would we have preferred a 1930s style “lost decade” for equities, or an Irish-style house price collapse, complete with ghost villages and mass negative equity?

Two things do worry me about ultra-low interest rates and unconventional monetary policy. One is that the cover they provided for structural and fiscal reform has not been used well. There has been a lot of tinkering, bringing millions more people into higher-rate taxation, but precious little proper reform of the UK’s bloated tax code.

The other is that what was supposed to be temporary is in danger of becoming semi-permanent. Politicians in the US, UK and Japan have deliberately appointed central bankers committed to the “lower for longer” mantra. It all reminds me of income tax – introduced as a temporary revenue-raiser in 1799, and still very much with us today.

jonathan.eley@ft.com

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